Fixed Annuities Overview
October 16, 2009
Fixed annuities have caught the attention of some investors who have taken a pounding from the world of stocks over the last few years and started looking for something a little less volatile. This type of investment, though it brings a much lower return on investment, does provide more stability. Are the lower returns and usually high exit fees worth the added security?
What is a Fixed Annuity?
A fixed annuity is an investment product where an insurance company guarantees a certain rate of return for an investor’s money. This guarantee is backed by the full faith and credit of the offering company (fixed annuities are not FDIC insured). The return on a fixed annuity is comparable to the rate of a Certificate of Deposit at the time the annuity is purchased.
Most companies offer an incentive where a bonus rate is added for a certain period of time. For example, XYZ insurance company offers a fixed annuity with a current rate of 4.00%, but if the investor deposits an initial investment of $100,000.00, they will receive a premium bonus of an additional 4.00% for the first year. The investor will receive 8.00% the first year and 4.00% the following years.
There is a “surrender schedule”Â attached to annuities, in which withdrawals during this time will incur a “surrender fee.”Â This fee is calculated based on how long the annuity has been owned (surrender fees are waived in the event of the death of the annuity owner).
In most cases, 10% of the principal or the interest earned can be redeemed over a twelve month period without incurring these penalties (please check your annuity contract before making any withdrawals). It is important to remember that annuities grow tax-deferred, so any distribution of earnings will be taxed as income.
Types of Fixed Annuities
Generally, annuities fall into two categories: immediate and deferred. These terms are based on the income stream options of the investment. In an immediate annuity, the investor deposits their money and immediately starts taking an income stream from the investment. On a deferred annuity, the funds are left in the product to grow at the fixed rate stated on the contract of the annuity.
The “pay out”Â from an annuity can vary based on the length of time the payments will occur, the value of the annuity and the age of the annuitant.
Fixed annuities have always been popular with retirees looking for guaranteed income and other types of investors seeking security have started using them as well. The “pay out”Â phase of the annuity can be set for a specific range of time (10 years, 20 years, etc.) or for the lifetime of one or two annuitants. If a person wanted to make sure that certain bills would be covered at all times regardless any other outside factors they might choose to invest in a fixed annuity.
A CNN Money article titled the trouble with annuities talks about the major disadvantage of fixed annuities as being opportunity cost.
“With such high exit fees, it’s prohibitively expensive to back out of a contract. So you could miss the rise in interest rates and improvement in market conditions that many experts are predicting.” Worst case: Your money ends up lagging behind price increases. “In an inflationary period, having 4% fixed in long-term money could be devastating,” says Salt Lake City financial planner Ray LeVitre, author of “The Retiring Boomer’s Financial Handbook.”
The Money article suggests that short- to intermediate-term high-quality corporate and municipal bonds could be an alternative to fixed annuities if safe growth is the objective. The argument is that they have fewer restrictions and can offer higher yields than CDs.
Of course, everyone’s situation and risk levels are different so if you’re not sure whether fixed annuities are for you then talk with a financial professional about how they fit into your investment strategy. Look for a financial advisor who doesn’t make a commission off of selling you annuities since that can present a conflict of interest.
What do you think about fixed annuities? Do you have any money invested in annuities?
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